Friday, July 31, 2009

Anyone want to puchase debt at an artificially low interest rate from a party that's highly unlikely to be able to pay you back? Anyone?

Surprisingly...you're not alone! The Treasury auctioned off another $39 billion last Wednesday (it's crazy that we get immune to seeing these huge numbers) in an auction that "drew poor demand."

It really looks like the government will have to monetize a lot of debt (as previously laid out in an excellent guest article we ran a few months ago - link below).

Heavy monetization usually leads to inflation. Problem is, the inflation/hyperinflation call appears to be the most obvious one on the planet right now. And the obvious call is often not what plays out in the world of investing.

So can the Fed inflate its way out of this? Or is Robert Prechter correct that you can't beat deflation in a credit based system?

L: So, Doug, we're sitting here in Vancouver, epicenter of many of our investments, thinking about the future. Meanwhile, the U.S. Treasury has announced some mind-boggling debt auctions for next week. Any comments?

Doug: Yes, the size of this auction coming up, $235 billion, is really rather shocking - especially when you consider that that's roughly the cost of the entire Viet Nam war. That was considered off the scale and lasted ten years. This action is just in one week. It's an amount that annualizes to $12 trillion - and it's still just starting.

They are going to have to borrow even more money to bail out all of the other banks that are going to fail (which is going to completely bankrupt the FDIC) and all the pension funds that are going to fail (which are insured by the Pension Benefit Guarantee Corporation). And there are lots of other financial catastrophes still on the runway.

This $235 billion is just a drop in the bucket - and I'm not entirely sure where they're going to get this money. If I were a foreigner and I already owned massive amounts of U.S. debt, would I want to buy that much more? That's especially questionable when any intelligent person can see that interest rates are being artificially suppressed. That makes buying this debt a guaranteed loss. It just doesn't make any sense to me.

The Chinese have, say, $2 trillion in foreign-denominated reserves, of which they say about $1.4 trillion is U.S. paper. They realize they're holding a burning match; they want to get rid of what they have, not buy more. But here's the scary thing: even if the Chinese lent the U.S. all their $2 trillion of FX, it would only cover this year's U.S. borrowing. Where is the U.S. going to get next year's? Because next year, it's going to need even more.

Let me be as clear as possible. There's no way out of this without major structural changes. It's not going to be just a disaster. Catastrophe is a better word.

L: Well, we heard today that the government of Dubai did a public offering of debt, and it had to be rescued by Abu Dhabi, because no one else would take it. We've heard other, similar stories. You'd think that at some point, these people would begin to worry that there might be a limit to how much debt they can peddle.

Doug: It seems to me that it's almost the endgame for this financial system. Since the depression of 1929 to 1946, we've had a worldwide economic boom; in its early stages it was quite real, since it was based on the savings that were accumulated during the depression. But over the last generation, starting in the 1980s, we've had a phony boom, driven entirely by debt.

The whole world is awash in debt. Individual consumers are head over heels in debt. State and local governments are head over heels in debt and going bankrupt. National governments all over the world are deeply in debt. And businesses that are catering to old patterns of consumption are going to find they have no earnings to service their debt with, and their assets are unsalable at acceptable prices.

One of the problems we've got here is that people confuse paper money with real capital. This is an important distinction that's being overlooked. Capital is actually just another word for "savings" - the excess of production over consumption. I can't emphasize that enough.

Unfortunately, people are used to thinking of capital as being the same as the dollar bills or other paper money in their wallets - and that can be created out of thin air. But capital can't be created out of thin air.

So, I'm very concerned that all these governments are going to destroy the world's monetary system in tandem. I don't know exactly how it will end up, but it's going to be really ugly. This is compounded by the fact everybody is looking to the governments to solve these problems. Government is the cause of these problems. And the people it employs are not the best and the brightest (how that ridiculous canard ever got traction astounds me) but the poorest and worst part of humanity.

Boobus americanus is looking to the type of people employed by their DMV or the TSA - albeit sporting prestigious degrees and expensive suits - to solve a millennial economic crisis. Good luck, suckers.

There are lots of reasons I say that the Greater Depression is going to be even worse than I think it's going to be.

L: That's a pretty negative view, Doug. What about all these green shoots we keep hearing about? Improved housing numbers, improved unemployment figures, the Dow up over 9,000 again... There are all these signs of recovery, but you say you don't see any green shoots. Are you myopic, or is everyone else in the world wrong?

Doug: I don't want to be seen as a perma-bear who's negative on the economy no matter what happens, but this is a time when I'm very happy to be a contrarian. In fact, I'm not negative. The future should be, and can be, better than all but what the most optimistic science fiction proposes.

So let me put it this way: I've believed for many years that the Greater Depression was in the cards, simply because I believe that cause has effect, and actions have consequences. All the distortions and misallocations of capital caused by government interventions in the economy have to be liquidated. So, no, I don't see any green shoots.

The talk of green shoots is all PR, because the morons running the government actually believe the economy is based on psychology. In fact, psychology has zero to do with it. If it did, then all the Zimbabwe government would have to do to solve their depression would be to slip everyone a Prozac tablet every day. But maybe we've already tried that here, since something like 50 million Americans are already on antidepressants....

There may seem to be green shoots in the same way it seemed that way for a while in 1930. After the stock market went down for six or eight months, it reached a temporary plateau and bounced back up. People thought it was just another recession, that they'd pull through as they did after World War I.

L: Safe to get back in the water.

Doug: Safe to get back in the water. But that's not the way it is this time. For example, people are now saying that housing is looking up because the rate of collapse has slowed. Of course, nothing goes straight down - or up - without retracements. The fact is that there's been immense overbuilding in housing for a long, long time. It's been the epicenter of speculation in the U.S. and many other places around the world.

There's a huge supply of square footage that people simply can't afford to live in. Even if Obama were to freeze people's mortgages, so they don't have to move out of their houses and into tent cities - who's going to pay the real estate taxes on those houses? The local governments are bankrupt, so, if anything, they'll want to raise real estate taxes.

And even if the federal government pays the local taxes - who's going to pay the utilities? Right now, oil and natural gas are at relatively low levels. When you see oil going back up over $100 - which I think you will in the next few years - and when you see natural gas doubling, or even tripling, in the next few years, people aren't going to be able to pay their utility bills.

Besides, all these McMansions are going to have a lot of deferred maintenance. The fact is that people have been living way above their means in terms of housing.

The same thing is true of cars. People have bigger, newer, more expensive cars than they did during the last recession, and they have lots more of them. Cars are on average of much higher quality now, unlike those of the 1970s - which you might call the first federal period of auto manufacturing; those were perhaps the worst cars ever made. During the 1980 - 1982 recession, the average car in the U.S. fleet was something like seven years old, and the average family didn't have more than one or two cars. Today, most cars are way above those of past years in quality. They basically last forever, the car fleet is almost brand new, and Americans have lots of cars.

What makes that even more troubling is that cars are no longer minor assets on most people's balance sheets. Back in those days, if they didn't buy them for cash, most people bought cars with a two- or maybe three-year financing. Now, everyone finances cars for five years or even leases them for that long. They've gone from being a minor asset to a major liability on families' balance sheets.

So, forget about the auto industry recovering. That's not going to happen. No green shoots there. In addition to the fact the cars that will be made by a nationalized and bankrupt GM and Chrysler will be politically correct crap. Nobody but people like Barney Frank and Nancy Pelosi will want to be caught dead in them.

Forget about housing, forget about autos, forget about almost anything you hear about on the news. For years, the whole world has overconsumed and lived above its means. It was great fun while it lasted, but now the party's over - and for a long time. You won't see any green shoots.

What you are going to see is lots more corporate bankruptcy and lots more unemployment.

All those people giving $150 massages and $40 haircuts are going to find that people can no longer afford them. Professions like personal trainers are going down the toilet. There are going to be lots of unemployed carpenters, financial planners, mortgage brokers, department store clerks, and car salesmen.

On the bright side, there will be legions of unemployed lawyers - unless they're bankruptcy specialists.

There are so many businesses - almost everything you look at, from restaurants to car washes - that are still catering to old patterns of production and consumption.

Many people are simply not going to be able to afford these things anymore, so lots more people who have been hanging on by their fingernails are going to fall off the cliff. What are they going to do to provide goods and services in a new world? I think the world is going to change more radically in the next ten years than it did from 1929 to 1945.

So, forget about green shoots. If you believe in them, you're going to be in for a sucker punch.

L: What about the companies that are rebounding, like Goldman Sachs?

Doug: Goldman is a special situation. Much of their competition has gone out of business, so a lot of what business there is, is going to Goldman. And they're very politically connected, so they'll be handling lots of state-sponsored deals. It's so brazen as to be shameless. I wouldn't be surprised if the American hoi polloi - with no jobs, no houses, no money, and no prospects - react in a most unpleasant manner against people who appear to be profiting from their distress.

L: Do you even believe Goldman's numbers, or is it all a function of them being able to change the rules that govern how they book things?

Doug: That's a good question. What can you believe today? The government has a vested interest in casting everything in the most favorable light possible. And the newspapers, magazines, and TV more or less parrot what they're told. I prefer not to clutter my mind with what official sources say but make my own observations and interpretations of what others put together. And my view is that the Greater Depression has barely even started.

L: What about recent reports that Americans actually have started saving again?

Doug: I believe that. That's definitely a major part of the cure, a very favorable thing. It's a sine qua non - critically important. Naturally, and stupidly, the government and mainstream economists are all against it. I say stupidly not as a pejorative, but in the sense that "stupid" means "an unwitting tendency towards self-destruction." They don't want to see people saving (the only cure), they want to see people consuming and spending. They're trying to prolong the totally unsustainable patterns of production and consumption the Long Boom engendered.

Fortunately, the average person is watching out for his or her own welfare, despite that being the opposite of what conventional economists are telling them to do. Saving is the only solution to the depression. In addition to massive deregulation, huge tax cuts, and the institution of a sound currency. But since those things are totally in the hands of the government, you can forget about them happening.

Look, you can't solve the problems created by decades of building debt with a few months of higher savings. It has to go on for years to rebuild the capital base.

L: Okay then, for the person who's expecting the sucker punch you mentioned, what's the best way to play it? Shorting masseuses and restaurants? Wall Street? What?

Doug: I want to go for the low-hanging fruit. What the stock market does and what the economy does are really two different things. Stocks could actually skyrocket because of all the dollars the government is creating. People might want to buy stocks because they actually are equity; they represent real wealth. I suspect that in this depression, the stock market isn't going to bottom until we're looking at dividends in the ten percent range across the board, after being cut from present levels, which implies a much lower stock market.

But do I want to make a bet that way?

Not particularly. All that money creation could drive the stock market up in spite of much lower earnings and a bad economic situation.

It seems to me that the sure bet is to be short bonds. Interest rates are going way up. Why? There will be tremendous demand for capital, of which there's a limited supply. Interest rates are the price of capital. So they're going up for that reason - and because of the trillions of paper dollars the government is creating, inflation is going to skyrocket. High inflation will itself guarantee high interest rates.

So, the trade of the decade is going to be to short long-term bonds and to go long precious metals (which are the only financial assets that are not also simultaneously someone else's liability). These are two excellent investment plays, but there are many others. We go into a lot of detail on the best ways to play them in The Casey Report and the International Speculator.

However, just as important is political diversification. The main risk you have is your own government. You have to diversify your assets out of the control of your government. This is even more important than picking the right investment today.

L: Great advice - thanks Doug.

Doug: Till next time.

To the editors of The Casey Report, shorting interest rates is one of their favorite investments of 2009... and there are different ways to do it. Learn all about how you can participate in the huge gains this investment promises in Chief Economist Bud Conrad's new report - just click here.

Of note, Treasuries were up today - who the heck is still buying these things? A mystery to most market observants, indeed.

Meanwhile Green Shoots have proven to be unkind to the Greenback, which closed down today, just a shade above it's low for 2009.

So what do you think - is the dollar toast, or is it poised to climb if/when this rally finally cools off? If you haven't already, please take a minute to give us your take in our dollar sentiment survey.

Wednesday, July 29, 2009

This morning, the US Department of Energy reported, well, HUGE inventories in oil. Oil's decline hastened on the news.

I'm wondering if oil has placed in its short term top, on it's way back down to the $40 range, or perhaps lower (maybe even $20 as predicted here?)

After rallying north of $140 last summer, oil will post a decidedly "lower high" if we have indeed already seen the short term top in the black goo. Whether or not it posts a lower low remains to be seen, but I wouldn't rule it out.

Many folks get outright pissed if you suggest that oil could fall...in fact a recent outraged commenter referred to me as a "moron."

Now that very well may be the case, but let me ask, who could have pictured $3 natural gas, when prices looked like they'd never dip below $10 again, and everyone was talking about Peak Drilling in North America?

Peak Oil is not as scary when demand evaporates faster than supply comes offline. Sure, things may get ugly again if and when the global economy actually recovers, but that won't help your portfolio in the interim. If you're thinking long term, I commend you, that's just not for me any longer.

And remember that the last time oil rolled over, the equity markets were soon to follow. It will be interesting to see if a top in oil again precedes a stock market collapse.

Tuesday, July 28, 2009

In the inflation/deflation debate, there's certainly no shortage of moving parts factoring into the outcome. Thus, I have to admit that although I've been leaning towards the deflation side of late, at the end of the day I don't have a clue (nor does anyone else, honestly).

One strong argument on the inflation side is that there are just not enough foreign investors to choke down all of the US debt that is being flooded onto the market.

This is the first case of mutual assured destruction we've seen since the Cold War, this of the financial variety rather than the nuclear variety. If you think the long bond is toast, you'll want to pay close attention to this piece, as our stellar guest author team of David Galland and Bud Conrad peel back the covers on the latest in foreign investment in the US.

Here at Casey Research, we’ve been watching the actions of foreign holders of U.S. dollars as closely as a Las Vegas pit boss watches a card player on a $1 million winning streak.

Many of those in the deflation camp largely, or entirely, ignore the potential role these foreign holders may play in the drama now unfolding. But in fact, foreigners have, over the last decade, been by far the single most important source of buying for U.S. Treasuries.

Given the Treasury’s need to flog on the order of $3 trillion worth of its unbacked paper this year just to keep the government’s doors open – and that is a four- or fivefold increase over 2008 – the foreign buyers not only have to show up for the Treasury auctions, they have to show up in droves.

In mid-July, the Associated Press reported that “Foreign demand for long-term U.S. financial assets dropped by the largest amount in four months in May, as Japan and Russia trimmed their holdings of Treasury securities . . . foreigners actually sold $19.8 billion more long-term U.S. securities than they purchased in May. That compared with net purchases of $11.5 billion in April.”

Below you see the big picture of all cross-border flows in May as published by the U.S. Treasury. It shows both foreign investment in the U.S. and U.S. investment abroad. It includes Treasuries, agencies, corporate bonds, equities, and short-term instruments like T-bills. Foreigners bought a lot of T-bills when the credit crisis became acute.

This should be a serious situation with a big drop in foreign investible funds for meeting U.S. borrowing needs. The borrowing by households and business has dropped close to zero, decreasing demand, while government borrowing has jumped but is still smaller than the private borrowing drop. The Fed has added some lending.

A look at just the longer-term Securities (not T-bills) is even more convincing of the slowing of lending by foreigners:

This decrease in credit should pressure rates higher.

And here is the breakdown of foreign investment into the U.S. Foreigners only continued to buy Treasuries, shunning new investment and selling off agencies in the riskier real estate market.

It’s not for nothing that the Goldman Sachs Secretary of the Treasury Timothy Geithner is hotfooting it around the world lately, last week to Saudi Arabia and the UAE… last month to China.

The purpose of his trip, Geithner told reporters in Paris, he was doing this tour ”to make sure we keep working with governments around the world to continue to provide enough support to lift this global economy back to a sustained pattern of growth."

Translation: Look here, we’re all in this together. If you jump ship now, we’re all doomed… DOOMED, I say!

But the fact remains that the foreign holders of U.S. dollars have it within their ability – either deliberately or inadvertently as the result of a panic setting in – to literally destroy the U.S. currency.

The latest report shows Russia and longtime monetary ally Japan edging toward the door. China and the oil-exporting nations continue to convert an increasingly moderate amount of their trade surplus into Treasury bills – but not on a nearly large enough scale to meet the inflated (and inflating) borrowing needs of the utterly bankrupt U.S. government. And how long will they continue to show up, when an increasing number of other foreign buyers start selling their Treasuries? No one likes to be the last one to leave a party, especially when the bananas flambé has tipped over on the floor and the curtains are on fire.

Put simply, the only thing now standing between the U.S. dollar holding its own and an almost overnight debasement (and history has shown us that when things go wrong with a currency, they can go wrong very quickly) is the willingness of foreigners to play nice. This was never a threat that the Japanese had to deal with during the worst of their recent dark days, but it’s a very real risk here and now in the United States.

That that risk sits on top of the monetary inflation that has been the steady response of the U.S. government so far – and will continue to be its response as the economy further erodes – is not something to be sniffed at.

On July 17, Bloomberg reported that “China’s finance ministry failed to meet its debt-sale target for a third time in two weeks at a 182-day bill sale, according to traders at Galaxy Securities Co. and China Citic Bank in Beijing. The ministry had tried to sell 20 billion yuan of bills and only sold 18.51 billion yuan, traders said. The average yield for the bills sold was 1.6011 percent, they said.”

Here’s our take on this news item: The problem from the Chinese government's point of view is that they were not able to borrow as much money as they wanted, in the light that they are now spending at a very fast clip with a big stimulus program to keep their own economy (bubble?) growing. So how can they fund the spending? They can sell off the stash of foreign-currency-denominated holdings they are sitting on. That could mean Treasuries dumped on the world market.

There are other alternatives, like getting the People's Bank of China to print up some new money for the government, which would inflate the renminbi (RMB) and decrease its international price and attractiveness. They might like to let the RMB fall to encourage exports and keep relative worker pay low on the world competitive scene. But they are also trying to make the RMB a world currency by itself, so they don't want it to look weak and at risk.

Our guess is that they are selling Treasuries and not telling.

[Ed. Note: In latest news this week, Chinese Prime Minister Wen Jiabao said China “will use its foreign exchange reserves to support and accelerate overseas expansions and acquisitions by Chinese companies.” Jiabao called it China’s “going out” strategy. Going out (with a bang), though, may be a better description of what the U.S. will ultimately do.]

This is what The Casey Report, Casey Research’s flagship publication, does: spotting budding trends in the economy and the markets, and then devising ways to profit from them. A strategy that – as thousands of happy subscribers can vouch for – is paying off... and paying off big. Right now, one of our favorite plays, and surest bets, on the economic quagmire we’re in is an investment that is almost guaranteed to be a winner. Let Casey Chief Economist Bud Conrad tell you all about it in his free report. Click here to learn more.

In honor of our ongoing bear market rally - which appears to be getting a bit long in the tooth to say the least - I thought we should channel the wisdom and charisma of the legendary Peter Tomarken.

You may remember Peter as the host of classic 80's game show Press Your Luck. In the spirit of history rhyming if not repeating, let's tune in with our heroes of yore to see if we can glean how much longer this raging campfire of a good time can continue in the equity markets.

Going long stocks today? Know someone who is? Repeat after me - no whammies, no whammies...

It's another "all or nothing" day in the markets - with equities down, the US Dollar and Japanese Yen are, of course, up. This time joined by - surprise - our old friend, the Australian dollar (ugh - got chased out of that position too early :( )

Looking at a 6-month chart of the dollar, it's doesn't look pretty - or does it? Is the dollar on a one-way train to the cellar, or is it finding a bottom and ready to party?

Is the dollar about to fall out of bed...or just the basement window?

(Source: BarChart.com)

Take our quick poll and let us know what you think the dollar's going to do over the next 2-3 months. We'll be tallying the results this week, in order to compile an unofficial "dollar sentiment" index for readers!

Monday, July 27, 2009

Legendary investor and China bull Jim Rogers told Bloomberg that he hasn't bought any new Chinese stocks since November. He said they've risen too far, too fast, and that they will "probably collapse" at some point. Then, he'll buy more.

Rogers is investing in commodities in lieu of equities as a way to play the China story.

We have a special treat for readers today...we were fortunate recently to conduct an interview with Jay from MarketFolly.com, one of the very top blogs on finance and investing. Jay places a special focus on what the gurus are buying, especially the who's who of hedge fund managers.

His coverage is second-to-none, a true must-read. We broke this interview up into two parts. Part 1 is below, with part 2 coming soon...enjoy! (And be sure to check out MarketFolly.com for more of Jay's great coverage and insights)

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CBM: Jay, can you give us a little background about your investment philosophy?

MF:My investment philosophy is really a hybrid of multiple styles but it really comes down to just long/short equity. Firstly, I like to focus on macro/secular themes. Then, I like to drilldown the fundamentals of whatever the sector/industry may be that I'm looking at for the 'why'.

Lastly, I like to use technical analysis to set buy points, sell points, and stops to determine the 'when' and the 'how.' I'm an equities guy and always have been, though I occassionally get into other asset classes when opportunities arise. So, I use the best of both worlds in my hybrid approach as I think you can never have too much information.

CBM:I’d love to hear a little about your evolution as an investor…what led you to develop this outlook on the investment world?

MF:I started investing and began tracking and learning from some of the big name hedge fund managers (Julian Robertson, Seth Klarman, David Einhorn, etc). Then I dabbled in trading in a separate account to try it out and had some success there too. So I started to see the benefits of both styles and tried to develop my own style to kind of combine both. So, I like to keep a core equity position and then trade around the other portion as certain signals dictate.

CBM:OK very cool. That’s a perfect lead-in to MarketFolly, your blog…what inspired you to start it?

MF:Yea I started MarketFolly.com since I noticed there was an empty niche in the financial blogosphere. No one was really tracking hedge fund movements in depth. So, since I was already tracking hedge funds for myself, I figured I could extend my familiarity on the subject to others interested.

I started to track numerous hedge funds on the blog and then added more commentary on numerous other topics as it went along. In the end, I thought I could provide a useful resource for others since I do it for myself anyways, so it worked out well.

CBM:When you started blogging, did you ever imagine you’d develop such a large following? Your readership is huge!

MF:No way. I started really cranking out content on a regular basis back in July of 2008 with 0 readers. Then, a year later, MarketFolly has over 4000 subscribers and receives over 6,500 hits on the site each day.

Needless to say it never ceases to amaze me how fast it has grown. I'd attribute it to the fact that I've just stepped right into a specific niche in the financial blogosphere.

CBM:That's amazing - good for you. So now tell us a little about how you gear MarketFolly towards your readers. Especially as it pertains to your personal research and investment philosophy.

MF:Well, MarketFolly's prime content is our hedge fund portfolio tracking series. Four times a year we siphon through tons of hedge fund 13F filings to determine what the big managers have been buying and selling. We're currently tracking 40+ funds and have plans to add even more, but we'll probably need some help to do so! We also cover the various 13D and 13G filings that funds make throughout the year too.

Additionally, we just started our hedge fund manager profile series over the past few months where we take a look at the background and investment styles of some of the best managers in the game. Then lastly, we focus on hedge fund news, macro trends, and market commentary. We'll post up some technical analysis, some secular themes we might be seeing, etc.

Basically, I just like to cover everything that I find interesting in my own research, with an obvious emphasis on hedge funds since that's what readers mainly come to the site for. We've got a nice blend of both institutional and retail investors/traders so there is a little bit of something for everyone on the site.

Stay tuned for Part 2 of this interview, coming soon! In the meantime, be sure to visit MarketFolly.com for the latest low down from hedge fund land.

Ed note: MarketFolly turned the tables and interviewed me as well - you can read the piece here.

How do you master the maddeningly difficult exercise of trading? As we mentioned this morning, paper (imaginary) trading just doesn't cut it. You don't have the stomach churning fear of losing money when the market goes against you.

No, the only way to do it is to get out there and do it yourself. I read a good piece of advice yesterday actually - start with a stake so small, you won't mind losing it...because you probably will the first time!

Then you can examine what went wrong, and improve your methods next time.

Trading is fascinating because it's a constant learning process. If it were easy, there would be a lot of millionaires running around who made their fortune in the market, and that's simply not the case.

It is possible to become "good" though, I truly believe that (and I say that not as someone who is good, just someone who tries to learn and improve everyday). To help you on your quest to master the markets, I hope this guess piece by expert trader Jeffrey Kennedy is a helpful one, as he tackles three basic tenets of trading...

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The Three Phases of a Trader's Education: Psychology, Money Management, MethodJuly 27, 2009

Methodology. The first phase is that all-too-familiar quest for the Holy Grail – a trading system that never fails. After spending thousands of dollars on books, seminars and trading systems, the aspiring trader eventually realizes that no such system exists.

Money Management. So, after getting frustrated with wasting time and money, the up-and-coming trader begins to understand the need for money management, risking only a small percentage of a portfolio on a given trade versus too large a bet.

Psychology. The third phase is realizing how important psychology is – not only personal psychology but also the psychology of crowds.

But it would be better to go through these phases in the opposite direction. I actually read of this idea in a magazine a few months ago but, for the life of me, can’t find the article. Even so, with a measly 15 years of experience under my belt and an expensive Ph.D. from S.H.K. University (i.e., School of Hard Knocks), I wholeheartedly agree. Aspiring traders should begin their journey at phase three and work backward.

I believe the first step in becoming a consistently successful trader is to understand how psychology plays out in your own make-up and in the way the crowd reacts to changes in the markets. The reason for this is that a trader must realize that once he or she makes a trade, logic no longer applies. This is because the emotions of fear and greed take precedence – fear of losing money and greed for more money.

Once the aspiring trader understands this psychology, it’s easier to understand why it’s important to have a defined investment methodology and, more importantly, the discipline to follow it. New traders must realize that once they join a crowd, they lose their individuality. Worse yet, crowd psychology impairs their judgment, because crowds are wrong more often than not, typically selling at market bottoms and buying at market tops.

Moving onto phase two, after the aspiring trader understands a bit of psychology, he or she can focus on money management. Money management is an important subject and deserves much more than just a few sentences. Even so, there are two issues that I believe are critical to grasp: (1) risk in terms of individual trades and (2) risk as a percentage of account size.

When sizing up a trading opportunity, the rule-of-thumb I go by is 3:1. That is, if my risk on a given trading opportunity is $500, then the profit objective for that trade should equal $1,500, or more. With regard to risk as a percentage of account size, I’m more than comfortable utilizing the same guidelines that many professional money managers use – 1%-3% of the account per position. If your trading account is $100,000, then you should risk no more than $3,000 on a single position. Following this guideline not only helps to contain losses if one’s trade decision is incorrect, but it also insures longevity. It’s one thing to have a winning quarter; the real trick is to have a winning quarter next year and the year after.

When aspiring traders grasp the importance of psychology and money management, they should then move to phase three – determining their methodology, a defined and unwavering way of examining price action. I principally use the Wave Principle as my methodology. However, wave analysis certainly isn’t the only way to view price action. One can choose candlestick charts, Dow Theory, cycles, etc. My best advice in this realm is that whatever you choose to use, it should be simple. In fact, it should be simple enough to put on the back of a business card, because, like an appliance, the fewer parts it has, the less likely it is to break down.

Jeffrey Kennedy is the Chief Commodity Analyst at Elliott Wave International (EWI). With more than 15 years of experience as a technical analyst, he writes and edits Futures Junctures, EWI's premier commodity forecasting service.

I've been keeping quiet on the subject of healthcare reform, because, well, what is there to say? It's a joke...we need less regulation, not more...and after all, who is going to pay for it? Nuff said.

For the final word on the subject, let's turn it over to our favorite cartoonist, Mr. Steve Sack.

You can check out more of Steve's great cartoon's here. He's been gracious enough to give us permission to post them from time to time.

Many folks will tell you that trading on paper is the best way to get started. Our buddy Brian Hunt writes today that this advice is crap!

Becoming a good trader isn't just about learning about charts or buying cheap assets. It's about suppressing the desire to "make it all" on one big trade... learning how to take small losses... and learning when it's time to simply sit out the game for a while.

Paper trading doesn't get you any "live fire" training on overcoming your emotions. It's like trying to learn how to hit a baseball by swinging an imaginary bat. So what's the new trader to do?

I agree wholeheartedly with Brian. When I was a senior in college, my good friend Joe and I each opened up a Scottrade account with $500, the minimum amount allowed.

We loaded all of our eggs in one basket - he bought Bally's Total Fitness, and I was fortunate enough to buy Dick's Sporting Goods.

Every day, every hour, we'd watch the tickers on our respective stocks. If DKS ended Friday on a positive note, I'd be on a high through the weekend. When Bally's tumbled, I was razzing him on his lack of investment prowess.

It was great fun, and addicting, and most important of all, educational. My stomach would churn if DKS slumped a few bucks - at one point my paper losses almost totalled $80! Fortunately for me, DKS rallied and by the time graduation had come around, I had nearly doubled my initial stake.

So if you find yourself watching a market from the sidelines, please realize that the best way to learn it inside and out is to actually get in the game! You don't have to put a ton of capital on the line - just start with a small stake, and see what you can make out of it!

L:Doug, you wrote in an email that you've been shaking your head over the latest antics of Supreme Court nomination and appointment. Care to tell us why?

Doug: Well, the whole thing is a pointless circus. The whole uproar over the "wise Latina" remark is irrelevant, and all the hours of intense scrutiny people are devoting to examining the alleged thoughts of Sotomayor are a waste of time. It serves absolutely no useful purpose whatsoever.

L: None whatsoever? Wouldn't it matter if a justice got in who might be more harmful than another to the economy or civil liberties?

Doug: No, not at all. The kind of justice who might do some good could never make it through our highly politicized appointment process, so it's a choice between Tweedle Dumb and Tweedle Dumber. It just doesn't matter. But, for what it's worth, Sotomayor seems to have all the wrong instincts.

Besides, the Supreme Court has drifted so far from what it's supposed to do that the court itself doesn't matter.

The Supreme Court has a very simple mission; it's supposed to safeguard the Constitution. The U.S. Constitution and its first ten amendments (the Bill of Rights) were adopted and ratified simultaneously. Though imperfect, it's actually a pretty clear and easy-to-understand document. All a Supreme Court justice should have to do is read the Constitution to see if the law in question is constitutional, in other words, falls within the authority spelled out in the Constitution. It's that simple, and it doesn't take a lawyer - in fact, a lawyer's training, with all its emphasis on precedent and interpretation, is the exact opposite of what you want in a Supreme Court justice.

So the weight of precedent and so-called law that has built up over the years is basically junk. Most decisions reflect not what the Constitution says, or even what's equitable, but the political views of the judges - who are all political appointees.

The vast majority of the Supreme Court's precedent should be scrapped. They should start from scratch, and with a copy of the Constitution in hand, and strike down any law that the Constitution does not specifically authorize. Article One, Section 8, makes it absolutely clear that any powers not given to the government in the Constitution are reserved to the states and to the people. Amendments 9 and 10 of the Bill of Rights reinforce that. But they're completely disregarded, like everything else in that document, which was made to shield the individual against the state.

L: That would eliminate most of the federal government - the SEC, the FDA, HEW, HUD, DOA, DOT, IRS, BATF, FBI, CIA, and who knows how many other agencies - leaving little besides the military and the post office.

Doug: Yes, and I would go further and say that it's not just the Supreme Court but the entire U.S. government that no longer serves any useful purpose.

Although the U.S. Constitution is perhaps the best in the world, because a) it's very brief, and b) other than spelling out some technicalities like the number of senators per state, or that the president must be born in the U.S., it mostly describes what the government can't do, not what it can - and certainly not what it should. But it's not perfect by any means.

Why, for instance, does it designate the Post Office as a function of government? In point of fact, anything that needs doing in a free society will be done by entrepreneurs, for a profit. If nobody can make a profit doing something, it's proof the good or service isn't wanted or needed.

The minimalist government described in the Constitution would be a vast improvement over the one we have now, which is completely counterproductive. It does the exact opposite of what is needed economically and meddles all over the world creating enemies we wouldn't otherwise have.

But getting back to the law, the state of the law in the U.S. is ridiculous in the extreme. We have so many laws and regulations implementing them, their volumes fill entire libraries. Nobody can even read the amount churned out every day, let alone what's been accumulated at an accelerating pace over the years. Forget about understanding the law thoroughly and being able to administer it with justice. The whole system is a farce. The saying "Ignorance of the law is no excuse" is fatuous in today's world.

And that's only on a practical level. More fundamentally, one must ask: What is justice?

I've always liked to think about it as getting what you deserve. And what do you deserve? Only what you've earned. All these people who think they deserve free health care, or a job, or a plasma screen TV, simply because they radiate heat at 98.6 degrees, or because they were born in a certain place, or because they have a certain skin color - it's all bunk. There's no such thing as a "just" wage. There's only what you earn.

L: I agree with you about the entitlement mentality, of course, but that's not really a matter of justice, it's just another politically created cancer eating out the heart of what was once the most creative and prosperous society on earth. On the other hand, your idea of relating justice to earnings is new to me - and it maps very well, because, for a company, earnings can be negative. So, if you do something wrong in life, that is to say, you aggress upon others and harm them or their property, you owe them some sort of restitution in order to set things right again (or as right as can be). So, as an individual, you can deserve to pay for your crimes - it's a negative earning on your personal income statement.

Doug: Right. Yes. Putting someone in prison does nothing to make the victim whole. Most people are in prison for victimless crimes anyway. And what happens if a company really screws up? It goes bankrupt.

L: And can ultimately be liquidated... which is what happens to people who do too much harm to others. Or it's what should happen, in a just society.

Doug: Yes, exactly. Listen, all of this is much simpler than people make it out to be. All you really need to know about justice, you learned in kindergarten: Keep your hands to yourself and keep your promises. Those are the only two laws we really need in society: Don't harm other people or their property, and do what you say you're going to do.

But perhaps it's possible to simplify things even further. Following the example of physicists, who are always trying to simplify their laws and boil them down to fewer, more all-encompassing principles, I've simplified these two basic laws that make profitable social interaction possible, into one. The whole of the law should be:

Do What Thou Wilt... But Be Prepared to Accept the Consequences.

That's all you really need to understand. Everyone, even a child or a dog, can understand it.

So all this hoopla over Supreme Court nominations is all a fantastic waste of time. You'd be better off watching paint dry - who knows, you might think of some valuable new idea during that quiet time.

L: I won't disagree. But this isn't very encouraging to investors; you're basically saying that the U.S. is hosed, and nothing and no one can save it.

Doug: Theoretically, yes, it can be saved. But practically... I'm saying that there's no politically feasible way to appoint a Supreme Court that would put the U.S. back on a constitutional basis of operation. That would indeed be exactly what the economy needs; it would get the government completely out of the way, allowing the market to liquidate all the accumulated mistakes of decades of mismanagement, and thus clearing the way for solid, healthy, and even sustainable growth, to use a word that's popular today. But that's not going to happen.

The good news, however, is that the government creates an excellent environment for speculators. The whole Supreme Court side show tells me that the trends we're betting on are solid. And that means that the kinds of investments we recommend in The Casey Report remain on track.

We're expecting the actions of the U.S. and other government to be highly inflationary, but that won't show up until after price destruction from the downturn slows. Bets on rising interest rates, a weakening U.S. dollar, etc. may stress our intestinal fortitude pretty severely in the short term. That makes the futility of expecting anything useful from the U.S. Supreme Court an encouraging sign; many will suffer as the economy worsens, but smart investors who identify the underlying causes correctly need not be among them.

L: So... are you an optimist or a pessimist?

Doug: I'm a pessimistic optimist, of course.

L: Okay then - thanks for your time.

Doug: Till next week.

Recognizing, analyzing, and betting on budding trends in the economy and markets is what The Casey Report does... and what has made its subscribers handsome returns in the past. For example, in 2007, way before "subprime meltdown" was a household term, we saw trouble brewing on the horizon. We advised our subscribers to short bond insurer MBIA, a company that seemed to stand squarely in the way of the avalanche thundering downhill - and we were right, bagging a total return of 1,166%.

While that deal is done, there's always another one... and right now we've found another potential mega-winner. Let Casey Chief Economist Bud Conrad tell you about his favorite investment of 2009 - just click here.

Guru Marc Faber scoffs at China's latest reported GDP numbers - remarking that the Chinese government knows their GDP numbers three years in advance!

He estimates that when all sectors in China are averaged out, the country is likely growing at 2-3% per year - a far cry from the 8% that is being reported.

Furthermore, he comments that China has an overinvestment bubble, which is not fixed by adding more stimulus.

I'd be a bit careful about China, he says.

I love the Morgan Stanley analyst who comes on after Faber and says he is turning wildly bullish on China based on more aggressive earnings growth estimates...I wanna smoke the green shoots he's having!

Here's a short clip of Bud Conrad, Casey Research's Chief Economist, on CNBC last Thursday. Bud has been pounding the table for investors to buy gold (since much lower prices) and short long bonds for some time.

The buy gold trade has been a good one thus far, and Bud now believes that betting on long term interest rates to rise is THE trade to make right now.

He starts talking around minute 4:20.

TBT and RRPIX are two of the most popular ETF plays on this trade.

If you like what Bud has to say, you may want to check out The Casey Report, where he provides his in-depth analysis each month.

Saturday, July 25, 2009

If you're bearish like me, you may have found yourself wondering earlier in the week:

How the hell did Intel report results that good?

Intel is not a company that juices quarterly results (cough, GE, cough) - so the odds are they really did sell as many chips as advertised. But how? Is the green shoots crowd correct?

I grilled some of my Intel contacts this week to shed some light on the mystery.

Answer: The Chinese Government!

Not reported in the mainstream media, internal executives quiety admitted internally that the Chinese government made "large purchases" during Q2.

That fits - China seems to be driving everything right now. The commodity recovery. The stock market recovery - you think the US is hot...the Shanghai index has boomed 85% from its lows!

But how sustainable is this? I have to wonder. This is a V-shaped recovery that appeared to be impossible a few months ago.

China's been juicing the money supply for sure...I just read that the Chinese money supply shot up over 28.5% in June alone. Now that's a recipe for a good time.

I'm just skeptical that any of this can end well. Seems like the drunk on a big binge, who gets up the next morning and cracks open a beer. Sure the old "hair of the dog" is an effective short term solution, but eventually, all good things must come to an end.

So I believe caution is still the order of the day (and I wish I was following my own advice, as you'll see below). Markets can, of course, continue to surprise us to the upside - but I can't figure out what's different fundamentally now, as very few excesses seem to have been corrected. Thus, I'm cautious that the March lows will be taken out again before this is all said and done.

Business Idea - Barter, Anyone?

Had a random idea while waiting in line for my morning coffee yesterday. With tax rates on the rise globally, shouldn't we see a dramatic rise in barter?

Cash transactions are easily traced, and thus taxed. Barter is supposed to be taxed, but much easier to doctor up.

I could see businesses increasingly turning to barter as a means of obtaining goods. Plus, you're now insulated from currency risk, as the goods have their own inherent value. I know there are some barter exchanges out there, some publicly traded.

Just a random thought to share, which you may be able to apply profitably in your investing or entrepreneurial ventures. I'll continue to noodle on this topic, and please comment or email any thoughts on over.

Quick Reader Survey - Please Share Your Thoughs!

I tossed together a quick 3-question reader survey, and I'd appreciate it if you could take a minute or two to share your thoughts and suggestions with me using the survey link here.

I bought the break own - then cotton broke right down! Still, there does appear to be a support shelf around the current price level, so I will hold for now. Will sell on the customary 15-day low stop.

Friday, July 24, 2009

It seems like these days, EVERYONE is looking a natural gas prices, wondering "how could they be so low?" As recently as a few years ago, "The Natty" was selling for over $16 - how could it now be languishing just above 3?

It's often said in the commodity world that the best cure for high prices is high prices. That's exactly what's happened in the natural gas market, as North America's "peak natural gas" situation has been reversed by the miracles of innovation.

The free market solving our energy needs - what a novel idea, huh!

So if the cure for high prices is high prices, is the reverse also true? Is natural gas destined to bounce back, as suppliers inevitably turn off production that is no longer profitable. Read on to find out in this excellent piece, shared with us by noted guest author David Galland...

***

Is Natural Gas Cheap?By David Galland, Casey Research

At the height of its late 2005 rally, natural gas in the U.S. was selling for just over $16/MMBtu, 350% higher than today’s price of $3.56. The oil/gas ratio, now over 18, is an all-time high… suggesting that natural gas is dirt cheap. So, it’s a buy, right?

In a phrase, not exactly.

According to a recent report by Natural Gas Intelligence, U.S. natural gas available for production “has jumped 58% in the past four years, driven by improved drilling techniques and the discovery of huge shale fields in Texas, Louisiana, Arkansas and Pennsylvania, according to a report issued Thursday by the nonprofit Potential Gas Committee (PGC).”

According to the report, the increase in gas discoveries and production improvements means that North America shouldn’t have to be concerned about gas supplies for up to 100 years!

Dr. Marc Bustin provided an overview of the situation in the May edition of Casey Energy Opportunities.

***

In the United States, the tremendous growth in natural gas resources and estimated recoverable natural gas, particularly from gas shales, just in the last two years (Figure 1) is sending tremors through the entire industry. These tremors include the risk of making obsolete the proposed $26 billion Alaskan and $16 billion northern Canadian pipelines to tap northern gas resources and a slue of proposed LNG terminals... unless they are for export!

The numbers currently kicked around are that something around 2,000 trillion cubic feet of gas are technically recoverable in the United States. At current production rates, this supply would last about 90 years.

Some analysts are predicting that even if the U.S. economy recovers in the next year, the amount of gas discovered to date in gas shales will severely dampen any increase in gas price for some time. According to a new study by energy consulting firm CERA (Cambridge Energy Research Associates), new technologies for unconventional gas fields are being applied so successfully that supply is essentially no longer a driver in either production or price in the North American gas market – whatever the market wants, North American gas fields can supply. CERA reports that natural gas production in the Lower 48 states has risen a startling 14% from 2007 to 2008, for example.

Major shale areas or formations in the U.S. and the estimated recoverable natural gas in 2006 and 2008. Modified from Daily Oil Bulletin (May 4, 2009).

Given the increase in production and the small slide in demand, the price of natural gas has fallen to around $3.50-$4.00 per MMBtu (down from $13 per MMBtu last summer). At these prices, many gas prospects are uneconomic, and thus there has been a marked decline in the number of wells being drilled. Rig activity (how many rigs are operating) is down about 50% in North America.

But here is where an interesting feedback mechanism kicks in. One of the characteristics of unconventional shale gas wells, and to a lesser extent natural gas wells in general, is that the production rate declines through time. Most shale wells’ production rates decline 60 to 90% in the first year. If you were a gas company trying to survive amidst today's low prices, the rate of return on your capital investment would also be painfully low for a significant amount of gas if this were your initial year of production.

Another complementary fact is that over 50% of natural gas consumed in the United States today is from wells drilled less than three years ago, and 25-30% of the gas produced today comes from wells drilled last year (Figure 2).

Hence it follows that if there are 50% fewer wells drilled this year (from the drop in rig activity), new production will decline about 35-40% by the end of the year, so there will be gas shortages. Those will in turn lead to higher North American prices, which in turn should lead to additional drilling.

Historical gas production in the U.S. showing the percentage of production from vintage of well (modified from Chesapeake April 2009 Investor presentation from original data of HIS Energy)

Everything else being equal (which it's not, this being the real, not the mathematical world), gas prices and drilling will see-saw until an equilibrium is reached. In detail, of course, things are more complicated, but it is pretty clear that gas prices will have to rise within the year, and the big losers will remain the more expensive plays that require higher gas prices to be economic.

Where will the gas price end up in the short term? A poll of analysts by Reuters suggests $6 MMBtu in 2010 (Daily Oil Bulletin, May 4, 2009), but I don’t think I would bet on a gas price based on a vote by analysts. At the same time, it's an interesting coincidence (or not – coincidence, that is) that many prospects become economic at around the $6 MMBtu range. Among them are the Haynesville and Marcellus shales – and it's no large leap from there to see their tremendous gas production potential acting as a buffer to gas prices going much higher in the near term.

***

Thus, while there may be some seasonal and relatively short-term trading opportunities in natural gas, the overhang of ready supply places a fairly firm cap on the price. Which begs the question, which big-trend energy opportunities should be getting our attention today?

Marin Katusa, who heads the Casey Research energy team, answers the question by, correctly, cataloging the opportunities according to geography.

In North America:

Geothermal -- the most interesting of the alternative energy sources, by a wide margin.

Nuclear.

Oil.

In Europe:

Unconventional gas has, by far, the most upside.

Unconventional oil.

Small hydro (such as run of river).

In Africa:

First and foremost, you want to avoid infrastructure plays (pipelines, refineries, etc). Then you want to look for areas with huge oil potential, which have been held off the market by concerns over political risk. I like what Lukas Lundin is doing in Ethiopia, Somalia, and Kenya, hunting for “elephants” with the idea of eventually selling the discoveries off to the Chinese.

In Asia:

Liquid Natural Gas (LNG)

Coal Bed Methane (CBM)

Lessons to Learn

There are a couple of useful lessons to be derived by investors looking to tap into the virtually unlimited opportunities in energy.

First, just because something is “cheap” doesn’t mean it can’t stay cheap, regardless of historical ratios -- if there has been a fundamental shift in the supply/demand equation. Which is very much the case with North American natural gas.

Secondly, geological and transport considerations make much of the energy complex a “local” market.

For example, while North America enjoys an abundance of natural gas, Europe is forced to rely on the heavy-handed Russians for the bulk of supplies. As you read this, there are companies looking to break the Russian grip by applying the same unconventional gas technologies that have so successfully built gas supplies in the U.S. -- technologies that are only just now being applied in Europe. Early investors could reap huge profits.

In short, the real opportunities are not found by simply “investing in energy” but rather by taking the time to understand the structural differences within the energy complex and cherry picking the special situations that invariably exist in a sector this large.

David Galland is the managing director of Casey Research, LLC., a private research firm providing independent analysis and investment recommendations to individual and institutional investors in North America and over 100 other countries around the globe. To learn more about the monthly Casey Energy Opportunities advisory, including a special three-month, fully guaranteed trial subscription, click here now.

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